Xerox Corporation Consolidated Statements of Income

Transcription

1 Xerox Corporation Consolidated Statements of Income Year Ended December 31, (in millions, except per-share data) Revenues Sales $ 7,234 $ 6,646 $ 8,325 Service, outsourcing and rentals 13,739 7,820 8,485 Finance income Total Revenues 21,633 15,179 17,608 Costs and Expenses Cost of sales 4,741 4,395 5,519 Cost of service, outsourcing and rentals 9,195 4,488 4,929 Equipment financing interest Research, development and engineering expenses Selling, administrative and general expenses 4,594 4,149 4,534 Restructuring and asset impairment charges 483 (8) 429 Acquisition-related costs Amortization of intangible assets Other expenses, net ,033 Total Costs and Expenses 20,818 14,552 17,687 Income (Loss) before Income Taxes and Equity Income (79) Income tax expense (benefit) (231) Equity in net income of unconsolidated affiliates Net Income Less: Net income attributable to noncontrolling interests Net Income Attributable to Xerox $ 606 $ 485 $ 230 Basic Earnings per Share $ 0.44 $ 0.56 $ 0.26 Diluted Earnings per Share $ 0.43 $ 0.55 $ 0.26 The accompanying notes are an integral part of these Consolidated. 54 Xerox 2010 Annual Report

2 Xerox Corporation Consolidated Balance Sheets December 31, (in millions, except share data in thousands) Assets Cash and cash equivalents $ 1,211 $ 3,799 Accounts receivable, net 2,826 1,702 Billed portion of finance receivables, net Finance receivables, net 2,287 2,396 Inventories Other current assets 1, Total current assets 8,639 9,731 Finance receivables due after one year, net 4,135 4,405 Equipment on operating leases, net Land, buildings and equipment, net 1,671 1,309 Investments in affiliates, at equity 1,291 1,056 Intangible assets, net 3, Goodwill 8,649 3,422 Deferred tax assets, long-term 540 1,640 Other long-term assets 1,774 1,320 Total Assets $ 30,600 $ 24,032 Liabilities and Equity Short-term debt and current portion of long-term debt $ 1,370 $ 988 Accounts payable 1,968 1,451 Accrued compensation and benefits costs Unearned income Other current liabilities 1,807 1,126 Total current liabilities 6,417 4,461 Long-term debt 7,237 8,276 Liability to subsidiary trust issuing preferred securities Pension and other benefit liabilities 2,071 1,884 Post-retirement medical benefits Other long-term liabilities Total Liabilities 18,092 16,841 Series A Convertible Preferred Stock 349 Common stock 1, Additional paid-in capital 6,580 2,493 Retained earnings 6,016 5,674 Accumulated other comprehensive loss (1,988) (1,988) Xerox shareholders equity 12,006 7,050 Noncontrolling interests Total Equity 12,159 7,191 Total Liabilities and Equity $ 30,600 $ 24,032 Shares of common stock issued and outstanding 1,397, ,381 The accompanying notes are an integral part of these Consolidated. Xerox 2010 Annual Report 55

3 Xerox Corporation Consolidated Statements of Cash Flows The accompanying notes are an integral part of these Consolidated. 56 Xerox 2010 Annual Report Year Ended December 31, (in millions) Cash Flows from Operating Activities: Net income $ 637 $ 516 $ 265 Adjustments required to reconcile net income to cash flows from operating activities: Depreciation and amortization 1, Provision for receivables Provision for inventory Deferred tax (benefit) expense (2) 120 (324) Net gain on sales of businesses and assets (18) (16) (21) Undistributed equity in net income of unconsolidated affiliates (37) (25) (53) Stock-based compensation Provision for litigation, net Payments for litigation, net (36) (28) (615) Restructuring and asset impairment charges 483 (8) 429 Payments for restructurings (213) (270) (131) Contributions to pension benefit plans (237) (122) (299) (Increase) decrease in accounts receivable and billed portion of finance receivables (118) Collections of deferred proceeds from sales of receivables 218 (Increase) decrease in inventories (151) 319 (114) Increase in equipment on operating leases (288) (267) (331) Decrease in finance receivables (Increase) decrease in other current and long-term assets (98) 129 (8) Increase in accounts payable and accrued compensation Decrease in other current and long-term liabilities (9) (100) (174) Net change in income tax assets and liabilities 229 (18) (92) Net change in derivative assets and liabilities 85 (56) 230 Other operating, net (104) Net cash provided by operating activities 2,726 2, Cash Flows from Investing Activities: Cost of additions to land, buildings and equipment (355) (95) (206) Proceeds from sales of land, buildings and equipment Cost of additions to internal use software (164) (98) (129) Acquisitions, net of cash acquired (1,734) (163) (155) Net change in escrow and other restricted investments 20 (6) 8 Other investing, net Net cash used in investing activities (2,178) (343) (441) Cash Flows from Financing Activities: Net proceeds (payments) on secured financings 1 (57) (227) Net (payments) proceeds on other debt (3,057) Common stock dividends (215) (149) (154) Preferred stock dividends (15) Proceeds from issuances of common stock Excess tax benefits from stock-based compensation 24 2 Payments to acquire treasury stock, including fees (812) Repurchases related to stock-based compensation (15) (12) (33) Other financing (22) (14) (19) Net cash (used in) provided by financing activities (3,116) 692 (311) Effect of exchange rate changes on cash and cash equivalents (20) 13 (57) (Decrease) increase in cash and cash equivalents (2,588) 2, Cash and cash equivalents at beginning of year 3,799 1,229 1,099 Cash and Cash Equivalents at End of Year $ 1,211 $ 3,799 $ 1,229

4 Xerox Corporation Consolidated Statements of Shareholders Equity Additional Xerox Non- Common Paid-In Treasury Retained Shareholders controlling Total (in millions) Stock (6) Capital Stock (6) Earnings AOCL Equity Interests Equity Balance at December 31, 2007 $ 920 $ 3,176 $ (31) $ 5,288 $ (765) $ 8,588 $ 103 $ 8,691 Net income Translation adjustments (1,364) (1,364) (3) (1,367) Cumulative effect of change in accounting principles (25) (25) (25) Changes in benefit plans (2) (286) (286) (286) Other unrealized losses, net Comprehensive (Loss) Income $ (1,446) $ 32 $ (1,414) Cash dividends declared common stock (3) (152) (152) (152) Stock option and incentive plans Payments to acquire treasury stock (812) (812) (812) Cancellation of treasury stock (59) (784) 843 Distributions to noncontrolling interests (15) (15) Balance at December 31, 2008 $ 866 $ 2,447 $ $ 5,341 $ (2,416) $ 6,238 $ 120 $ 6,358 Net income Translation adjustments Changes in benefit plans (2) (169) (169) (169) Other unrealized gains Comprehensive Income $ 913 $ 32 $ 945 Cash dividends declared common stock (3) (152) (152) (152) Stock option and incentive plans Tax loss on stock option and incentive plans, net (21) (21) (21) Distributions to noncontrolling interests (11) (11) Balance at December 31, 2009 $ 871 $ 2,493 $ $ 5,674 $ (1,988) $ 7,050 $ 141 $ 7,191 Net income Translation adjustments (35) (35) (35) Changes in benefit plans (2) Other unrealized gains, net Comprehensive Income $ 606 $ 31 $ 637 ACS acquisition (4) 490 3,825 4,315 4,315 Cash dividends declared common stock (3) (243) (243) (243) Cash dividends declared preferred stock (5) (21) (21) (21) Stock option and incentive plans Tax benefit on stock option and incentive plans, net Distributions to noncontrolling interests (19) (19) Balance at December 31, 2010 $ 1,398 $ 6,580 $ $ 6,016 $ (1,988) $ 12,006 $ 153 $ 12,159 Refer to Note 1 Accumulated Other Comprehensive Loss (AOCL) section for additional information. (2) Refer to Note 15 Employee Benefit Plans for additional information. (3) Cash dividends declared on common stock of $ in each of the four quarters in 2008, 2009 and (4) Refer to Note 3 Acquisitions for additional information. (5) Cash dividends declared on preferred stock of $12.22 per share in the first quarter of 2010 and $20 per share in each of the second, third and fourth quarters of (6) Refer to Note 19 Shareholders Equity for rollforward of shares. The accompanying notes are an integral part of these Consolidated. Xerox 2010 Annual Report 57

5 Note 1 Summary of Significant Accounting Policies References herein to we, us, our, the Company and Xerox refer to Xerox Corporation and its consolidated subsidiaries unless the context specifically requires otherwise. Description of Business and Basis of Presentation We are a $22 billion global enterprise for business process and document management. We provide essential back-office support through our broad portfolio of technology, services and outsourcing offerings. We also offer extensive business process outsourcing and information technology outsourcing services through Affiliated Computer Services, Inc. ( ACS ), which we acquired in February We develop, manufacture, market, service and finance a complete range of document equipment, software, solutions and services. Basis of Consolidation The Consolidated include the accounts of Xerox Corporation and all of our controlled subsidiary companies. All significant intercompany accounts and transactions have been eliminated. Investments in business entities in which we do not have control, but we have the ability to exercise significant influence over operating and financial policies (generally 20% to 50% ownership) are accounted for using the equity method of accounting. Operating results of acquired businesses are included in the Consolidated Statements of Income from the date of acquisition. We consolidate variable interest entities if we are deemed to be the primary beneficiary of the entity. Operating results for variable interest entities in which we are determined to be the primary beneficiary are included in the Consolidated Statements of Income from the date such determination is made. For convenience and ease of reference, we refer to the financial statement caption Income (Loss) before Income Taxes and Equity Income as pre-tax income or pre-tax loss throughout the Notes to the Consolidated. Use of Estimates The preparation of our Consolidated, in accordance with accounting principles generally accepted in the United States of America, requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities, as well as the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions are used for, but not limited to: (i) allocation of revenues and fair values in leases and other multiple element arrangements; (ii) accounting for residual values; (iii) economic lives of leased assets; (iv) revenue recognition for services under the percentage-of-completion method; (v) allowance for doubtful accounts; (vi) inventory valuation; (vii) restructuring and related charges; (viii) asset impairments; (ix) depreciable lives of assets; (x) useful lives of intangible assets; (xi) amortization period for customer contract costs; (xii) pension and post-retirement benefit plans; (xiii) income tax reserves and valuation allowances; and (xiv) contingency and litigation reserves. Future events and their effects cannot be predicted with certainty; accordingly, our accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of our Consolidated will change as new events occur, as more experience is acquired, as additional information is obtained and as our operating environment changes. Actual results could differ from those estimates. The following table summarizes certain significant charges that require management estimates for the three years ended December 31, 2010: Years Ended December 31, Expense/(Income) Restructuring provisions and asset impairments $ 483 $ (8) $ 429 Provisions for receivables Provisions for litigation and regulatory matters (4) Provisions for obsolete and excess inventory Depreciation and obsolescence of equipment on operating leases Depreciation of buildings and equipment Amortization of internal use software Amortization of product software 7 5 Amortization of acquired intangible assets (2) Amortization of customer contract costs 12 Defined pension benefits net periodic benefit cost Other post-retirement benefits net periodic benefit cost Deferred tax asset valuation allowance provisions 22 (11) 17 Includes net receivable adjustments of $(8), $(2) and $11 for 2010, 2009 and 2008, respectively. (2) Includes amortization of $4 for patents, which is included in cost of sales for each period presented. Changes in Estimates In the ordinary course of accounting for items discussed above, we make changes in estimates as appropriate and as we become aware of circumstances surrounding those estimates. Such changes and refinements in estimation methodologies are reflected in reported results of operations in the period in which the changes are made and, if material, their effects are disclosed in the Notes to the Consolidated. 58 Xerox 2010 Annual Report

6 New Accounting Standards and Accounting Changes FASB Establishes Accounting Standards Codification In 2009, the FASB established the Accounting Standards Codification ( the Codification or ASC ) as the official single source of authoritative U.S. generally accepted accounting principles ( GAAP ). All existing accounting standards are superseded. All other accounting guidance not included in the Codification is considered non-authoritative. The Codification also includes all relevant Securities and Exchange Commission ( SEC ) guidance organized using the same topical structure in separate sections within the Codification. The FASB updates the Codification by issuing Accounting Standard Updates ( ASUs ). The Codification did not change GAAP, but only the way GAAP is organized and presented. In order to ease the transition to the Codification, we are providing the Codification cross-reference alongside the references to the standards issued and adopted prior to the adoption of the Codification. Fair Value Accounting In 2010, the FASB issued ASU No which amended Fair Value Measurements and Disclosures Overall (ASC Topic ). This update required a gross presentation of activities within the Level 3 rollforward and added a new requirement to disclose transfers in and out of Level 1 and 2 measurements. The update also clarified the following existing disclosure requirements in ASC regarding: i) the level of disaggregation of fair value measurements; and ii) the disclosures regarding inputs and valuation techniques. This update was effective for our fiscal year beginning January 1, 2010 except for the gross presentation of the Level 3 roll-forward information, which is effective for our fiscal year beginning January 1, The principle impact from this update is to expand disclosures regarding our fair value measurements. In 2009, the FASB issued the following updates that provide additional application guidance and require enhanced disclosures regarding fair value measurements: FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (ASC Topic ) FSP FAS and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (ASC Topic ) FSP FAS and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (ASC Topic ) ASU No , Fair Value Measurements and Disclosures (Topic 820) Measuring Liabilities at Fair Value We adopted these updates in 2009 and the adoptions did not have a material effect on our financial condition or results of operations. In 2006, the FASB issued SFAS No. 157, Fair Value Measurements (ASC Topic 820) which defined fair value, established a market-based framework or hierarchy for measuring fair value and expanded disclosures about fair value measurements. This guidance is applicable whenever another accounting pronouncement requires or permits assets and liabilities to be measured at fair value. It did not expand or require any new fair value measures; however, the application of this statement may change current practice. We adopted this guidance for financial assets and liabilities effective January 1, 2008 and for nonfinancial assets and liabilities effective January 1, The adoption of this guidance, which primarily affected the valuation of our derivative contracts, did not have a material effect on our financial condition or results of operations. Business Combinations In 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (ASC Topic 805). This guidance requires the acquiring entity in a business combination to recognize the full fair value of assets acquired and liabilities assumed in the transaction (whether a full or partial acquisition); establishes the acquisition date fair value as the measurement objective for all assets acquired and liabilities assumed; requires expensing of most transaction and restructuring costs; and requires the acquirer to disclose the information needed to evaluate and understand the nature and financial effect of the business combination. We adopted this guidance effective January 1, 2009 and have applied it to all business combinations prospectively from that date. The impact of ASC Topic 805 on our consolidated financial statements depends upon the nature, terms and size of the acquisitions we consummate in the future. Revenue Recognition In 2009, the FASB issued the following ASUs: ASU No , Revenue Recognition (ASC Topic 605) Multiple- Deliverable Revenue Arrangements, a consensus of the FASB Emerging Issues Task Force. This guidance modified previous requirements by allowing the use of the best estimate of selling price in the absence of vendor-specific objective evidence ( VSOE ) or verifiable objective evidence ( VOE ) (now referred to as TPE standing for third-party evidence) for determining the selling price of a deliverable. A vendor is now required to use its best estimate of the selling price when more objective evidence of the selling price cannot be determined. In addition, the residual method of allocating arrangement consideration is no longer permitted. ASU No , Software (ASC Topic 985) Certain Revenue Arrangements That Include Software Elements, a consensus of the FASB Emerging Issues Task Force. This guidance modified the scope of ASC subtopic Software-Revenue Recognition to exclude from its requirements (a) non-software components of tangible products and (b) software components of tangible products that are sold, licensed or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product s essential functionality. Xerox 2010 Annual Report 59

7 We adopted these updates effective for our fiscal year beginning January 1, 2010 and are applying them prospectively from that date for new or materially modified arrangements. The adoption of these updates did not have a material effect on our financial condition or results of operations. See Summary of Accounting Policies Revenue recognition Multiple Element Arrangements for further information regarding our adoption of ASU No With respect to the new software guidance in ASU No , the modification in the scope of the industry-specific software revenue recognition guidance did not result in a change in the recognition of revenue for our equipment and services. Software included within our equipment and services has generally been considered incidental and therefore has been, and will continue to be, accounted for as part of the sale of equipment or services. Most of our equipment have both software and non-software components that function together to deliver the equipment s essential functionality. The software scope modification is also not expected to change the recognition of revenue for software accessories sold in connection with our equipment or free-standing software sales as these transactions will continue to be accounted for under the industry-specific software revenue recognition guidance as separate software elements. See Summary of Accounting Policies Revenue Recognition Software for further information. Other Accounting Changes In 2010, the FASB issued the following codification updates: ASU which amended Foreign Currency (ASC Topic 830). The purpose of this update was to codify the SEC staff s view on certain foreign currency issues related to investments in Venezuela. See Foreign Currency Translation and Re-measurement section below for further information regarding our operations in Venezuela. ASU which amended Receivables (ASC Topic 310) and requires significantly increased disclosures regarding the credit quality of an entity s financing receivables and its allowance for credit losses. In addition, this update requires an entity to disclose credit quality indicators past due information, and modifications of its financing receivables. The disclosures are first effective for our 2010 Annual Report. The principal impact from this update was increased disclosures concerning the details of finance receivables and the related provisions and reserves for credit losses. See Note 4 Receivables, Net for the disclosures required by this update. In 2009, the FASB issued the following codification updates: ASU which amended Transfers and Servicing (ASC Topic 860): Accounting for Transfers of Financial Assets. This update removed the concept of a qualifying special-purpose entity and removed the exception from applying consolidation guidance to these entities. This update also clarified the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. We adopted this update effective for our fiscal year beginning January 1, Certain accounts receivable sale arrangements were modified in order to qualify for sale accounting under this updated guidance. The adoption of this update did not have a material effect on our financial condition or results of operations. ASU which amended Consolidations (ASC Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities. This update required an analysis to determine whether a variable interest gives the entity a controlling financial interest in a variable interest entity. It also required an ongoing reassessment and eliminates the quantitative approach previously required for determining whether an entity is the primary beneficiary. We adopted this update effective for our fiscal year beginning January 1, 2010 and the adoption did not have a material effect on our financial condition or results of operations. Since the implementation of the codification, the FASB has issued several ASUs. Except for the ASUs discussed above, the remaining ASUs issued by the FASB entail technical corrections to existing guidance or affect guidance related to unique/infrequent transactions or specialized industries/entities and therefore have minimal, if any, impact on the Company. Summary of Accounting Policies Revenue Recognition We generate revenue through services, the sale and rental of equipment, supplies and income associated with the financing of our equipment sales. Revenue is recognized when earned. More specifically, revenue related to services and sales of our products is recognized as follows: Equipment: Revenues from the sale of equipment, including those from sales-type leases, are recognized at the time of sale or at the inception of the lease, as appropriate. For equipment sales that require us to install the product at the customer location, revenue is recognized when the equipment has been delivered and installed at the customer location. Sales of customer-installable products are recognized upon shipment or receipt by the customer according to the customer s shipping terms. Revenues from equipment under other leases and similar arrangements are accounted for by the operating lease method and are recognized as earned over the lease term, which is generally on a straight-line basis. Services: Technical service revenues are derived primarily from maintenance contracts on our equipment sold to customers and are recognized over the term of the contracts. A substantial portion of our products are sold with full service maintenance agreements for which the customer typically pays a base service fee plus a variable amount based on usage. As a consequence, other than the product warranty obligations associated with certain of our low-end products, we do not have any significant product warranty obligations, including any obligations under customer satisfaction programs. Revenues associated with outsourcing services are generally recognized as services are rendered, which is generally on the basis of the number of accounts or transactions processed. Information technology processing revenues are recognized as services are provided to the customer, generally at the contractual selling prices of resources consumed or capacity utilized by our customers. In those service arrangements where final acceptance of a system or solution by the 60 Xerox 2010 Annual Report

8 customer is required, revenue is deferred until all acceptance criteria have been met. Revenues on cost-reimbursable contracts are recognized by applying an estimated factor to costs as incurred, determined by the contract provisions and prior experience. Revenues on unit-price contracts are recognized at the contractual selling prices as work is completed and accepted by the customer. Revenues on time-andmaterial contracts are recognized at the contractual rates as the labor hours and direct expenses are incurred. In connection with our services arrangements, we incur costs to originate these long-term contracts and to perform the migration, transition and setup activities necessary to enable us to perform under the terms of the arrangement. We capitalize certain incremental direct costs that are related to the contract origination or transition, implementation and setup activities and amortize them over the term of the arrangement. From time to time, we also provide certain inducements to customers in the form of various arrangements, including contractual credits, which are capitalized and amortized as a reduction of revenue over the term of the contract. Customer-related deferred set-up/transition and inducement costs are being amortized over a weighted average period of approximately eight years. Initial direct costs of an arrangement are capitalized and amortized over the contractual service period. Long-lived assets used in the fulfillment of the arrangements are capitalized and depreciated over the shorter of their useful life or the term of the contract if an asset is contract-specific. Revenues on certain fixed price contracts where we provide information technology system development and implementation services are recognized over the contract term based on the percentage of development and implementation services that are provided during the period compared with the total estimated development and implementation services to be provided over the entire contract. These services require that we perform significant, extensive and complex design, development, modification or implementation of our customers systems. Performance will often extend over long periods, and our right to receive future payment depends on our future performance in accordance with the agreement. During 2010, we recognized approximately $270 of revenue using the percentage-of-completion accounting method. The percentage-of-completion methodology involves recognizing probable and reasonably estimable revenue using the percentage of services completed, on a current cumulative cost to estimated total cost basis, using a reasonably consistent profit margin over the period. Due to the long-term nature of these projects, developing the estimates of costs often requires significant judgment. Factors that must be considered in estimating the progress of work completed and ultimate cost of the projects include, but are not limited to, the availability of labor and labor productivity, the nature and complexity of the work to be performed and the impact of delayed performance. If changes occur in delivery, productivity or other factors used in developing the estimates of costs or revenues, we revise our cost and revenue estimates, which may result in increases or decreases in revenues and costs, and such revisions are reflected in income in the period in which the facts that give rise to that revision become known. Revenues earned in excess of related billings are accrued, whereas billings in excess of revenues earned are deferred until the related services are provided. We recognize revenues for non-refundable, upfront implementation fees on a straight-line basis over the period between the initiations of the ongoing services through the end of the contract term. Sales to distributors and resellers: We utilize distributors and resellers to sell certain of our products to end-user customers. We refer to our distributor and reseller network as our two-tier distribution model. Sales to distributors and resellers are generally recognized as revenue when products are sold to such distributors and resellers. Distributors and resellers participate in various cooperative marketing and other programs, and we record provisions for these programs as a reduction to revenue when the sales occur. Similarly, we account for our estimates of sales returns and other allowances when the sales occur based on our historical experience. In certain instances, we may provide lease financing to end-user customers who purchased equipment we sold to distributors or resellers. We compete with other third-party leasing companies with respect to the lease financing provided to these end-user customers. Supplies: Supplies revenue generally is recognized upon shipment or utilization by customers in accordance with the sales terms. Software: Most of our equipment has both software and non-software components that function together to deliver the equipment s essential functionality and therefore they are accounted for together as part of the equipment sales or services revenues. Software accessories sold in connection with our equipment sales, as well as free-standing software sales, are accounted for as separate deliverables or elements. In most cases, these software products are sold as part of multiple-element arrangements and include software maintenance agreements for the delivery of technical service, as well as unspecified upgrades or enhancements on a when-and-if-available basis. In those software accessory and free-standing software arrangements that include more than one element, we allocate the revenue among the elements based on vendor-specific objective evidence ( VSOE ) of fair value. VSOE of fair value is based on the price charged when the deliverable is sold separately by us on a regular basis and not as part of the multiple-element arrangement. Revenue allocated to software is normally recognized upon delivery, while revenue allocated to the software maintenance element is recognized ratably over the term of the arrangement. Leases: The two primary accounting provisions which we use to classify transactions as sales-type or operating leases are: 1) a review of the lease term to determine if it is equal to or greater than 75% of the economic life of the equipment; and 2) a review of the present value of the minimum lease payments to determine if they are equal to or greater than 90% of the fair market value of the equipment at the inception of the lease. Our leases in our Latin America operations have historically been recorded as operating leases given the cancellable nature of the contract or because the recoverability of the lease investment is deemed not to be predictable at lease inception. Xerox 2010 Annual Report 61

9 For purposes of determining the economic life, we consider the most objective measure to be the original contract term, since most equipment is returned by lessees at or near the end of the contracted term. The economic life of most of our products is five years, since this represents the most frequent contractual lease term for our principal products and only a small percentage of our leases have original terms longer than five years. We continually evaluate the economic life of both existing and newly introduced products for purposes of this determination. Residual values, if any, are established at lease inception using estimates of fair value at the end of the lease term. The vast majority of our leases that qualify as sales-type are noncancelable and include cancellation penalties approximately equal to the full value of the lease receivables. A portion of our business involves sales to governmental units. Governmental units are those entities that have statutorily defined funding or annual budgets that are determined by their legislative bodies. Certain of our governmental contracts may have cancellation provisions or renewal clauses that are required by law, such as 1) those dependant on fiscal funding outside of a governmental unit s control; 2) those that can be cancelled if deemed in the best interest of the governmental unit s taxpayers; or 3) those that must be renewed each fiscal year, given limitations that may exist on entering into multi-year contracts that are imposed by statute. In these circumstances, we carefully evaluate these contracts to assess whether cancellation is remote. The evaluation of a lease agreement with a renewal option includes an assessment as to whether the renewal is reasonably assured based on the apparent intent and our experience of such governmental unit. We further ensure that the contract provisions described above are offered only in instances where required by law. Where such contract terms are not legally required, we consider the arrangement to be cancelable and account for the lease as an operating lease. After the initial lease of equipment to our customers, we may enter subsequent transactions with the same customer whereby we extend the term. Revenue from such lease extensions is typically recognized over the extension period. Bundled Lease Arrangements: We sell our products and services under bundled lease arrangements, which typically include equipment, service, supplies and financing components for which the customer pays a single negotiated fixed minimum monthly payment for all elements over the contractual lease term. Approximately 40% of our equipment sales revenue is related to sales made under bundled lease arrangements. These arrangements also typically include an incremental, variable component for page volumes in excess of contractual page volume minimums, which are often expressed in terms of price-per-page. The fixed minimum monthly payments are multiplied by the number of months in the contract term to arrive at the total fixed minimum payments that the customer is obligated to make ( fixed payments ) over the lease term. The payments associated with page volumes in excess of the minimums are contingent on whether or not such minimums are exceeded ( contingent payments ). In applying our lease accounting methodology, we only consider the fixed payments for purposes of allocating to the relative fair value elements of the contract. Contingent payments, if any, are recognized as revenue in the period when the customer exceeds the minimum copy volumes specified in the contract. Revenues under bundled arrangements are allocated considering the relative selling prices of the lease and non-lease deliverables included in the bundled arrangement. Lease deliverables include maintenance and executory costs, equipment and financing, while non-lease deliverables generally consist of the supplies and nonmaintenance services. The allocation for the lease deliverables begins by allocating revenues to the maintenance and executory costs plus profit thereon. These elements are generally recognized over the term of the lease as service revenue. The remaining amounts are allocated to the equipment and financing elements which are subjected to the accounting estimates noted above under Leases. Multiple Element Arrangements: We enter into the following revenue arrangements that may consist of multiple deliverables: Bundled lease arrangements, which typically include both lease deliverables and non-lease deliverables as described above. Sales of equipment with a related full-service maintenance agreement. Contracts for multiple types of outsourcing services, as well as professional and value-added services. For instance, we may contract for an implementation or development project and also provide services to operate the system over a period of time; or we may contract to scan, manage and store customer documents. If a deliverable in a multiple-element arrangement is subject to specific guidance, such as leased equipment in our bundled lease arrangements (which is subject to specific leasing guidance) or accessory software (which is subject to software revenue recognition guidance), that deliverable is separated from the arrangement based on its relative selling price (the relative selling price method see below) and accounted for in accordance with such specific guidance. The remaining deliverables in a multiple-element arrangement are accounted for based on the following guidance. A multiple-element arrangement is separated into more than one unit of accounting if both of the following criteria are met: The delivered item(s) has value to the customer on a stand-alone basis; and If the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. If these criteria are not met, the arrangement is accounted for as one unit of accounting and the recognition of revenue is generally upon delivery/completion or ratably as a single unit of accounting over the contractual service period. 62 Xerox 2010 Annual Report

10 Consideration in a multiple-element arrangement is allocated at the inception of the arrangement to all deliverables on the basis of the relative selling price. When applying the relative selling price method, the selling price for each deliverable is determined using VSOE of the selling price, or TPE of the selling price. If neither VSOE nor TPE of the selling price exists for a deliverable, we will use our best estimate of the selling price for that deliverable. The new guidance with respect to multiple-element arrangements did not change the allocation of arrangement consideration to the units of accounting or the pattern and timing of revenue recognition for those units. Normally our equipment and services will qualify as separate units of accounting, which are the majority of our multiple-element arrangements. In addition, under previous guidance, consideration for multiple-element arrangements was allocated based on VSOE or TPE, since products and services are generally sold separately or the selling price is determinable based on competitor prices for similar deliverables. As a result, for substantially all of our multiple-element arrangements, we will continue using VSOE or TPE to allocate the arrangement consideration to each respective deliverable. Although infrequent, under previous guidance with respect to multipleelement arrangements, if we were unable to establish the selling price using VSOE or TPE, arrangement consideration was allocated using the residual method or recognized ratably over the contractual service period. However, since the new guidance allows for the use of our best estimate of the selling price in our allocation of arrangement consideration if VSOE or TPE is not determinable, we now use our best estimate of selling price in those infrequent situations. The objective of using estimated selling price-based methodology is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. Accordingly, we determine our best estimate of selling price considering multiple factors including, but not limited to, geographies, market conditions, competitive landscape, internal costs, gross margin objectives and pricing practices. Estimated selling price based methodology generally will apply to an insignificant proportion of our arrangements with multiple deliverables. Cash and Cash Equivalents Cash and cash equivalents consist of cash on hand, including money-market funds, and investments with original maturities of three months or less. Restricted Cash and Investments As more fully discussed in Note 17 Contingencies, various litigation matters in Brazil require us to make cash deposits as a condition of continuing the litigation. In addition, several of our secured financing arrangements and other contracts require us to post cash collateral or maintain minimum cash balances in escrow. These cash amounts are classified in our Consolidated Balance Sheets based on when the cash will be contractually or judicially released (refer to Note 10 Supplementary Financial Information for classification of amounts). Restricted cash amounts at December 31, 2010 and 2009 were as follows: Tax and labor litigation deposits in Brazil $ 276 $ 240 Escrow and cash collections related to receivable sales Other restricted cash 7 20 Total Restricted Cash and Investments $ 371 $ 289 Inventories Inventories are carried at the lower of average cost or market. Inventories also include equipment that is returned at the end of the lease term. Returned equipment is recorded at the lower of remaining net book value or salvage value. Salvage value consists of the estimated market value (generally determined based on replacement cost) of the salvageable component parts, which are expected to be used in the remanufacturing process. We regularly review inventory quantities and record a provision for excess and/or obsolete inventory based primarily on our estimated forecast of product demand, production requirements and servicing commitments. Several factors may influence the realizability of our inventories, including our decision to exit a product line, technological changes and new product development. The provision for excess and/or obsolete raw materials and equipment inventories is based primarily on near-term forecasts of product demand and include consideration of new product introductions, as well as changes in remanufacturing strategies. The provision for excess and/or obsolete service parts inventory is based primarily on projected servicing requirements over the life of the related equipment populations. Land, Buildings and Equipment and Equipment on Operating Leases Land, buildings and equipment are recorded at cost. Buildings and equipment are depreciated over their estimated useful lives. Leasehold improvements are depreciated over the shorter of the lease term or the estimated useful life. Equipment on operating leases is depreciated to estimated salvage value over the lease term. Depreciation is computed using the straight-line method. Significant improvements are capitalized and maintenance and repairs are expensed. Refer to Note 5 Inventories and Equipment on Operating Leases, Net and Note 6 Land, Buildings and Equipment, Net for further discussion. Software Internal Use and Product We capitalize direct costs associated with developing, purchasing or otherwise acquiring software for internal use and amortize these costs on a straight-line basis over the expected useful life of the software, beginning when the software is implemented ( Internal Use Software ). Costs incurred for upgrades and enhancements that will not result in additional functionality are expensed as incurred. Useful lives of Internal Use Software generally vary from three to 10 years. Xerox 2010 Annual Report 63

11 We also capitalize certain costs related to the development of software solutions to be sold to our customers upon reaching technological feasibility and amortize these costs based on estimated future revenues ( Product Software ). In recognition of the uncertainties involved in estimating revenue, that amortization is not less than straight-line amortization over the software s remaining estimated economic life. Useful lives of Product Software generally vary from three to 10 years. Amounts capitalized for Product Software are included in Cash Flows from Operations. Years Ended December 31, Additions to: Internal use software $ 164 $ 98 $ 129 Product software As of December 31, Capitalized costs, net: Internal use software $ 468 $ 354 Product software Goodwill and Other Intangible Assets Goodwill is tested for impairment annually or more frequently if an event or circumstance indicates that an impairment loss may have been incurred. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units and determination of the fair value of each reporting unit. We estimate the fair value of each reporting unit using a discounted cash flow methodology. This requires us to use significant judgment including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, the useful life over which cash flows will occur, determination of our weighted average cost of capital and relevant market data. Other intangible assets primarily consist of assets obtained in connection with business acquisitions, including installed customer base and distribution network relationships, patents on existing technology and trademarks. We apply an impairment evaluation whenever events or changes in business circumstances indicate that the carrying value of our intangible assets may not be recoverable. Other intangible assets are amortized on a straight-line basis over their estimated economic lives. We believe that the straight-line method of amortization reflects an appropriate allocation of the cost of the intangible assets to earnings in proportion to the amount of economic benefits obtained annually by the Company. Refer to Note 8 Goodwill and Intangible Assets, Net for further information. Impairment of Long-Lived Assets We review the recoverability of our long-lived assets, including buildings, equipment, internal-use software and other intangible assets, when events or changes in circumstances occur that indicate that the carrying value of the asset may not be recoverable. The assessment of possible impairment is based on our ability to recover the carrying value of the asset from the expected future pre-tax cash flows (undiscounted and without interest charges) of the related operations. If these cash flows are less than the carrying value of such asset, an impairment loss is recognized for the difference between estimated fair value and carrying value. Our primary measure of fair value is based on discounted cash flows. Treasury Stock We account for repurchased common stock under the cost method and include such Treasury stock as a component of our Common shareholders equity. Retirement of Treasury stock is recorded as a reduction of Common stock and Additional paid-in capital at the time such retirement is approved by our Board of Directors. Research, Development and Engineering ( RD&E ) Research, development and engineering costs are expensed as incurred. Sustaining engineering costs are incurred with respect to ongoing product improvements or environmental compliance after initial product launch. Our RD&E expense for the three years ended December 31, 2010 was as follows: R&D $ 653 $ 713 $ 750 Sustaining engineering Total RD&E Expense $ 781 $ 840 $ 884 Restructuring Charges Costs associated with exit or disposal activities, including lease termination costs and certain employee severance costs associated with restructuring, plant closing or other activity, are recognized when they are incurred. In those geographies where we have either a formal severance plan or a history of consistently providing severance benefits representing a substantive plan, we recognize severance costs when they are both probable and reasonably estimable. Refer to Note 9 Restructuring and Asset Impairment Charges for further information. Pension and Post-retirement Benefit Obligations We sponsor defined benefit pension plans in various forms in several countries covering employees who meet eligibility requirements. Retiree health benefit plans cover U.S. and Canadian employees for retiree medical costs. We employ a delayed recognition feature in measuring the costs of pension and post-retirement benefit plans. This requires changes in the benefit obligations and changes in the value of assets set aside to meet those obligations to be recognized not as they occur, but systematically and gradually over subsequent periods. All changes are ultimately recognized as components of net periodic benefit cost, except to the extent they may be offset by subsequent changes. At any point, changes that have been identified and quantified but not recognized as components of net periodic benefit cost, are recognized in Accumulated Other Comprehensive Loss, Net of tax. Several statistical and other factors that attempt to anticipate future events are used in calculating the expense, liability and asset values related to our pension and retiree health benefit plans. These factors include assumptions we make about the discount rate, expected return on plan assets, rate of increase in healthcare costs, the rate of future compensation increases, and mortality. Actual returns on plan assets are not immediately recognized in our income statement, due to the delayed recognition requirement. In calculating the expected return 64 Xerox 2010 Annual Report